Free Information to Help You Build Wealth in the Stock Market
Category Archives: Tyler Craig
November 14, 2013Posted by on
Perhaps no concepts is more well-known by the investing masses than diversification. The mere mention of the d-word usually conjures up images of eggs in a basket. Of course, this imagery arises from the popularity of the old advice to avoid placing all your eggs in one basket. Such an isolated bet runs the risk of losing too many eggs due to a single unforeseen basket drop. The safer approach, then, is to spread your eggs among numerous baskets.
In the context of investing the eggs represent money, or one’s trading capital, and the baskets represent different investment choices such as stocks, bonds, or real estate. Or, for a pure stock trader the baskets may represent buying multiple, preferably uncorrelated, stocks.
While egg spreading is a well-known form of diversification there are two other types of diversification worth consideration in your investing ventures: time and price diversification.
Time diversification adds in an additional measure of protection by spreading your bets over time. In other words, staggering your entry into multiple stocks over time is less risky than buying ten stocks all on the same day. This insulates you from losing too much money on any one big market selloff. For example, if you were looking to buy ten stocks it would be less risky to buy one every two days for the next month than to buy them all today. This tactic reduces the risk of incurring your max loss on all trades simultaneously.
Even if the market plummeted at the end of the month when you owned all ten stocks, they would be at different stages of their progression. Instead of incurring the max loss on all ten trades you would probably lock-in a gain on some, break-even on others, and only lose on a few.
Price diversification is the idea of buying shares of a stock over time as opposed to all at once. That way if prices decline you’re able to buy more shares at cheaper prices which lowers your average cost basis. In other words, we’re dollar cost averaging. Admittedly, this is probably a technique best suited for longer-term investors.
Suppose you have $10,000 you’d like to invest in the stock market in aggregate by purchasing the S&P 500 ETF (SPY). With the market at all-time highs you may be a bit scared that you’re buying the top. After all, we’ve gone up a long way over the past five years and knowing your luck right after you jump in the market will inevitably plummet. It’s Murphy’s law! While I doubt a crash is imminent, that’s always the fear when we put a whole bunch of money in the market all at once at the same price.
A safer approach would be to invest the $10K over time – which will in turn mean you are investing at different prices. If you put in $1K each month for the next ten months then you will be buying more shares of the SPY at different prices each time. With this approach your view of a market crash would shift from negative to positive. Rather than being a painful development it would actually be an opportunity to buy shares at lower prices that month thereby lowering your average cost and allowing you to make money quicker on the next market advance.
When developing your trading plan remember the many faces of diversification and apply them accordingly.
Tyler Craig, CMT
Rich Dad Education Elite Training Instructor
November 7, 2013Posted by on
Twitter mania descends on Wall Street today as the social media darling enters the public arena for the first time. While the financial punditry will be obsessively fawning over the initial public offering (IPO) today that doesn’t necessarily mean traders should too. Here are three things you need to know about trading IPOs.
1. The absence of any prior price action makes analyzing trades on new stocks virtually impossible.
IPOs are a bird of a different feather. Normally we have a bevy of data available to perform technical and fundamental analysis on to determine whether or not the stock in question is offering an attractive opportunity. Which leads to the next point…
2. You can’t really calculate the potential risk and reward for an IPO.
As traders we’re on a consistent search for low risk, high reward setups. The idea is to only purchase stocks when the potential reward is over twice as much as the potential risk. Normally we use prior support and resistance levels or other technical analysis tools to identify our exit points so we can calculate risk and reward. And therein lies the rub. With an IPO you have no prior price data and thus no way to spot support and resistance. In the end buying a brand new stock requires a bit too much guesswork with the potential payout. And, let’s be honest, most of us mere mortals are poor guessers.
3. If you must buy an IPO only use a small portion of your portfolio designated for speculative investments.
Suppose you have a $25,000 portfolio and are comfortable with using 10% of it in highly speculative trades. In that case it may be permissible to use a portion of the 10% – like say $1250 and buy the Twitter IPO with abandon. If it becomes the next hot stock delivering massive returns you’ll get to relish in the profits with all the other shareholders. More importantly, if the stock experiences a crash similar to Facebook (FB) following its public debut you will only lose a very small percentage of your portfolio.
I usually suggest waiting for a new stock to trade for a couple months to establish some price history before trading it. Once a trend has developed and multiple support and resistance levels are in play it will be easier to analyze potential trade ideas.
Fears of missing out if you don’t buy on the first few days of a company’s public existence are unfounded. If Twitter stock is the next big thing it will continue to provide opportunities months and years down the road.
Tyler Craig, CMT
Rich Dad Education Elite Training Instructor
October 31, 2013Posted by on
Making money in the long haul trading stocks is a simple numbers game. The sum of the winners needs to be larger than the sum of the losers. It’s not a matter of winning on 60% or 70% of your trades, it really comes down to how much you make on the winning trades versus how much you lose on the losing trades.
To improve your odds of success we usually suggest you only buy stocks that offer a 2 to 1 reward to risk ratio. This means the stock is offering $2 of potential reward for every $1 of potential risk. If you trade stocks providing this type of asymmetric payout you can be profitable even if you only win 40% of your trades.
In order to calculate the potential reward we must first establish a price target for how high the stock can realistically move within the time frame we’re considering. The formula for potential reward is target minus entry. For example, if we purchased a stock for $50 with a profit target of $55 the potential reward would be $5. Some traders obsess over complex ways to set profit targets, but you shouldn’t get too worked up over the exercise. Remember the true purpose of setting a target is not to predict exactly how high the stock will go before gravity takes hold. Rather, we simply want to make sure that the stock can realistically move up twice as much as what we’re risking. So if based on my stop loss I’m risking $2, then I want to make sure the stock can realistically rise $4.
You can use a few different methods for calculating the target.
- Use a prior resistance level.
- Use the Average True Range (ATR) indicator which tells you how much the stock moves on average per day.
- Look at prior upswings in the stock to determine the typical swing length. If it’s run-up $5 on average over the last four upswings, then it’s probably unrealistic to expect it to run-up $10 this go-around.
Here’s one example using Tractor Supply (TSCO) which currently boasts a bull retracement pattern. If we bought it above today’s high the entry would be about $71.80. To minimize the risk we could set a stop loss below today’s low around $70.50 making our risk per share $1.30. Since there is a prominent resistance level at $74.75 we could use that as the target making our reward per share $2.90 ($74.75- $71.80).
In sum, we’re risking $1.30 to make $2.90 which is more than a 2 to 1 reward to risk ratio.
Learn more about our Elite Stock Courses here.